On August 23, 2016, the Securities and Exchange Commission (the “SEC”) announced it had obtained agreement from four fund advisers affiliated with private equity giant Apollo Global Management (collectively, the “Apollo Funds”) to pay $52.7 million to settle claims that the advisers had failed to disclose to investors pertinent information relating to certain fees and loan agreements and been negligent in their supervision of a senior partner who had charged personal expenses to funds advised by them. The SEC enforcement action giving rise to the settlement is one among several forming a recent trend wherein the agency has pursued private equity firms for failure to properly disclose fees and conflicts of interest to fund investors.
In connection with the settlement, the SEC issued an administrative order (the “Order”) instituting the enforcement proceedings. The Order sets forth the relevant facts and the resulting conclusions drawn by the SEC, which are summarized as follows:
First and most expansively, the SEC examined the Apollo Funds’ practice -- one common throughout the private equity industry -- of entering into monitoring agreements with the portfolio companies held by funds they advised, pursuant to which the Apollo Funds provide business and financial consulting and advisory services in exchange for monitoring fees. However, the SEC found that from late 2011 through spring 2015, the Apollo Funds had terminated certain monitoring agreements following the private sale or initial public offering of a portfolio company and exercised rights held under the applicable monitoring fee agreement to accelerate the payment of future monitoring fees. The SEC concluded that, while the Apollo Funds had disclosed to investors their practice of receiving monitoring fees as well as the amounts of the monitoring fees accelerated following the acceleration, the Apollo Funds had failed to disclose that they were permitted under the monitoring fee agreements to accelerate future monitoring fees upon termination of such agreements. Due to their position as both recipients of the accelerated monitoring fee payments and advisors to the affected funds, the SEC asserted that the Apollo Funds could not effectively consent to the acceleration on the funds’ behalf.
Second, the SEC zeroed in on certain loans made in 2008 to the general partner (the “GP”) of Apollo Investment Fund VI, L.P. (“Fund VI”) by Fund VI and certain other parallel Apollo Funds (collectively, the “Lending Funds”) for the purpose of deferring taxes on carried interest that the limited partners of Fund VI would otherwise have owed. However, the SEC found that, while the Lending Funds had disclosed the amount of interest accrued on such loans and included such interest amounts as assets in their financial disclosures to investors, the Lending Funds had failed to disclose that the accrued interest would accrue solely to the capital account of the GP, rendering such disclosures materially misleading in the SEC’s eyes.
Third, the SEC catalogued improper expensing to Apollo-advised funds and their related portfolio companies of personal charges by a former Apollo Funds senior partner and found that the Apollo Funds had not exercised adequate supervision to prevent further inappropriate reimbursements, which took place over a long period and continued even after the Apollo Funds had been made aware of the partner’s earlier improprieties.
Fourth and finally, the SEC noted that the Apollo Funds had failed to adopt and implement policies and procedures designed to prevent the foregoing violations of the Investment Advisers Act of 1940 (the “Advisers Act”).
Based on its factual findings, the Order concluded that the Apollo Funds violated Sections 206(2) and 206(4) of the Advisers Act as well as Rules 206(4)-7 and 206(4)-8 promulgated thereunder. As a result, in addition to compliance with the terms of the settlement, the Order called for the Apollo Funds to cease and desist from committing or causing any further such violations.
In October 2015, the SEC brought an enforcement action against certain advisers affiliated with the Blackstone Group (“Blackstone”) for, among other things, failure to disclose the acceleration of monitoring fee payments. The order instituting the proceedings and accepting Blackstone’s settlement offer noted that “[b]ecause of its conflict of interest as the recipient of the accelerated monitoring fees ..., Blackstone could not effectively consent to [this] practice on behalf of the funds it advised.”
Over and above bringing enforcement actions, the SEC has also placed the fee practices of private equity firms in its rhetorical crosshairs. In May 2016, Andrew Ceresney, Director of the SEC’s Enforcement Division, gave a speech dedicated to private equity enforcement focusing on undisclosed fees and expenses and failure by private equity firms to adequately disclose conflicts of interest. Ceresney touted the SEC’s success in forcing “increased transparency” which has “fostered a healthy dialogue between investors and advisers on what sorts of fees are appropriate and who should receive the benefits of those fees.”
- The SEC’s recent focus on private equity firms’ fee arrangements, potential conflict of interest transactions and their disclosure is likely to continue and thus the conduct of these practices warrants reexamination by private equity clients, even when such practices may be considered to be standard and widespread in the private equity industry.
- Private equity clients should keep abreast of ongoing developments in SEC enforcement actions and the issuance of proposed and future regulations and make any corresponding changes to company practices to remain in compliance. In tandem with this, it is important to work together with counsel to assess the adequacy of existing and planned disclosures relating to fee arrangements or other potential generators of conflict of interest scrutiny. Not only will these measures reduce the likelihood of the SEC bringing an enforcement action, but in the event that an enforcement action is brought, the SEC will look favorably on strong internal controls and evidence of attempts to adapt to the ever-changing securities law landscape.